You are a foreign exchange trader specialized in the US dollar Swiss franc market (USD/CHF). One morning, you notice that the one-year dollar interest rate is 4%, while the one-year interest rate on Swiss francs is 2.7%. Today’s USD/CHF rate is $1.7.
(a) What spot rate do you expect for the USD/CHF in one year?
(b) You log onto your electronic brokerage account and find that the current quote for the 360- day forward rate on USD/CHF is 1.79. Is there an arbitrage opportunity? If so, describe how you would take profit from it and how much you would get if you invested $1. What do you anticipate if all of your fellow traders start doing the same?